What's the Difference Between Subsidized and Unsubsidized Student Loans?

Once you understand the basic difference between subsidized and unsubsidized student loans, you're off to a good start in figuring out the financial aid maze. There are a few other things to keep in mind:

Parents can sometimes take out federal loans to help pay for their dependent children's education. The federal loans for parents are called PLUS Loans. They're unsubsidized, meaning that the borrower is responsible for all accrued interest. The PLUS loans carry a higher interest rate than Perkins or Stafford Loans. For the 2010-2011 school year, the interest rate on PLUS loans is fixed at 8.5 percent [source: FinAid]. Parents applying for PLUS loans must pass a credit check. They're not required to file the FAFSA to apply for a PLUS loan.

Unsubsidized PLUS loans also are available for students in graduate and professional programs. Those students must file a FAFSA; the school will consider the maximum loan limits they have under the Stafford Loan program.

Just to complicate things a bit more, Stafford Loans are divided into two other categories, the Direct Loan program and the Federal Family Education Loan (FFELP) program. The difference is that in the Direct Loan program, you're borrowing directly from the federal government. In the FFELP program, you borrow from a bank. Schools decide which loan program they participate in. Some participate in both. The choice makes little practical difference to the student, except that those borrowing through FFELP must choose a bank, usually from a list of approved lenders [source: StudentAid].

Unsubsidized Stafford Loans can be an important part of a student's financial aid package. It's smart, however, to be aware of the interest that's mounting up while a student is in school, and during grace or deferment periods. Some people choose to pay the interest during those times even though they're waiting until they're out of school to start repaying the loan's principal. The amount each month is usually relatively low. Many people choose instead to add the unpaid interest that has been added to the principal when they begin to repay the loan. This process is called capitalization. The original principal plus the accrued interest becomes the new principal amount. Interest is then charged on that new amount. The person who pays back a loan in this way is, in part, paying interest on interest. Over time, a person who capitalizes deferred interest will pay more for his or her loan [source: Stafford].